Saturday, December 5, 2015

Have We Squeezed Everyone In Yet? Waiting For The Trap To Spring On the Bond Market

Alphaville's David Keohane gets a mention for a post we had in the queue and somehow misplaced.
I'm glad Bloomberg caught it.

From Bloomberg, Dec. 3:

There's Been a Bezzle-Fueled Boom in BondsEasy money and the confidence that comes with it conceals a wide variety of risk.

Economist John Kenneth Galbraith has written many words we should all
read, but one in particular is proving especially relevant as cracks in
the credit markets continue to spread.

That word is bezzle.
It describes the period in which an embezzler has stolen a man's money
but the victim does not yet realize he's been swindled. It is, as
Galbraith puts it, a time when there is a "net increase in psychic
wealth." Charlie Munger, Warren Buffett's longtime investment adviser,
later built on the idea with his coining of the word "febezzlement,"
which (perhaps unnecessarily) formally extends the concept to include
completely legal but nevertheless unexpected appropriations of wealth.

Whichever
term one chooses, it looks increasingly likely that the world has
experienced a massive fe(bezzle) in corporate credit.

Years
of low interest rates since the financial crisis have encouraged
investors to pile into the asset class, reaching for the higher yields
on offer from such securities as sliced-and-diced packages of commercial real estate loans,
leveraged loans, and crucially, corporate bonds. An ever-ready supply
of eager lenders and investors has kept borrowing costs low, enabling
companies to fund a share buyback and M&A spree that has helped propel the recovery in the stock market, fueling the wealth effect on the overall market.

The bezzle is what has enabled companies to be continuously rewarded
for rollup strategies or embarking on ever more-complex corporate
structures. It's what's allowed the average level of indebtedness at
U.S. companies to rise to its highest level in a decade.
It is the thing that has masked potential risks in the credit system,
leading to billions of dollars of underwriting fees for banks and a
market for new-issue bonds in which prices are only ever expected to *pop* thanks to a perceived massive imbalance of demand and supply.

It is what has allowed a host of emerging market bonds
to infiltrate the U.S. credit market, or the riskiness of benchmark
bond indexes quietly to increase. As David Keohane of FT Alphaville points out this morning,
citing a UBS analysis, the portion of triple-C issuers in the Citi U.S.
High-yield Cash Bond Index is currently at 13 percent using an average
of ratings from the big three bond graders. Using just the ratings of
Moody's, the most conservative of the three rating agencies, the
proportion of triple-Cs increases to 20 percent.

The confidence
that comes with the bezzle is what has allowed banks and investment
houses to enjoy higher fees or returns while simultaneously cutting back
on the number of credit analysts they employ. UBS analysts Matthew Mish
and Stephen Caprio have previously pointed out
that "simply put, the growth of the credit markets [has] not been
matched by the addition of research resources (e.g., credit analysts) in
many of the silos," citing the example of high-yield money
managers with one energy analyst responsible for covering
$200 billion in bonds outstanding across 300 separate debt issues....MORE